The Average Propensity to Consume Out of Full Wealth: Testing a New Measure Laurie Pounder

Full Wealth: The Right Measure of Wealth for Consumption  Lifecycle/PIH theory since Modigliani says consumption should depend on all current and future resources (including financial and human wealth.) Essentially a stock value of permanent income from today forward I call this PDV of all resources: “Modigliani full wealth” = M

Unprecedented Ability to Measure Full Wealth Health and Retirement Study  Expected present value of resources: M = Net Worth + Human Wealth Net Worth = 10 categories of assets less 3 categories of debt Human Wealth= Earnings+Pensions+Social Security+Other Transfers (deterministic for older households)

Full Wealth is Not Just Scaled-Up Net Worth Age Profile of Wealth Full Wealth Net worth

Full Wealth Has Less Variance… Coefficients of Variation CVMean Full Wealth0.99$738,100 Net Worth1.68$324,300 Income1.24$62,100 Consumption0.76$40,300

…and is more equally distributed Full Wealth Net worth Lorenz Curves

The Average Propensity to Consume Out of Full Wealth Lifecycle model: Very limited source of variation in C/M across households C/M changes only slowly over time (from mortality, changes in returns expectations, or changes in preferences) C/M does not change with income shocks if consumption responds quickly

Which Implies… Relative to C/Income or C/NetWorth, C/M Should Have: Lower variance Higher covariance over time Lower correlation with “circumstances” such as: –Income Profile Having a pension or the generosity of pension and social security benefits (income replacement rate in retirement) Earnings profile over lifetime –Past Income Shocks Also ∆(C/M) Should Have: Lower correlation with past shocks both to income and to full wealth

And the data says… Std. Dev.MeanMedianCV C/M C/M C/NW C/NW C/I C/I Lower and more consistent variance

Covariance 2001&2003 C/M0.70 C/NW0.37 C/I0.27 And higher covariance over time

Circumstances Traditional savings or consumption rates (C/I) have “noise” from circumstances, both cross- sectionally and longitudinally Examples: –Households expecting generous DB pension income will save less than otherwise identical households with little or no DB pension –Households experiencing a temporary positive income shock will save more that period

Lifecycle Model Illustrations

Comparison of Baseline to Household with Lower Retirement Income

Income Shocks

Comparison of Baseline and Shocked Household

Testing Circumstances  Circumstance: Generosity of retirement benefits (DB pension and Social Security)  Measure: RetRatio= Ratio of PV(Pension+Social Security) to Average Earnings Over Ages  Outcome: C/M is less correlated

Retirement/Earnings Ratio Bivariate OLS Coefficient & T-stat R2 std(C/M) 2001 on RetRatio0.003 (1.2) 0.00 std(C/NW) 2001 on RetRatio0.013*** (6.0) 0.03 std(C/I) 2001 on RetRatio0.005** (2.1) 0.01 std(C/M) 2003 on RetRatio (-0.4) 0.00 std(C/NW) 2003 on RetRatio0.016*** (4.8) 0.03 std(C/I) 2003 on RetRatio0.007** (2.3) 0.01 Coefficients represent fraction of standard deviation from mean so can be compared across dependent variables

Income Shocks  Circumstance: Past Income Shock  Measure: Change in Earnings over previous years  Outcome With Levels: results mixed: C/M less correlated than C/I in 2001; less correlated for large shocks in 2003

Income Shocks on Levels of Consumption Rates 2001 Dependent Variable → std(C/M)std(C/NW)std(C/I) Independent Variables↓ Y Shock ** (2.0)0.124* (1.6)-0.263***(-3.2) Y Shock (-0.7) (-0.8)-0.314***(-3.3) 2003std(C/M)std(C/NW)std(C/I) Y Shock (0.6)0.004 (0.4) (-1.3) Y Shock (1.4) (-0.8)0.094 (1.0)

2003 with Large Shocks 2003std(C/M)std(C/NW)std(C/I) >25% Negative Y Shock (-0.9) *** (-2.7) 0.641*** (6.1) >25% Positive Y Shock (0.9) 0.161* (1.7) *** (-4.4) >25% Negative Y Shock (0.2) ** (-2.3) 0.311** (2.5) >25% Positive Y Shock (1.0) (-0.6) (-0.2)

Change in C/M Less Correlated With Shocks Dependent Variable → ∆(C/M)∆(C/NW)∆(C/I) Independent Variables↓ Y Shock (-1.3)-.175** (-2.0).400*** (6.2) Y Shock (0.0).044 (0.4).168** (2.4)

Changes in M Since M is an expected value of current and future resources, any change in M must be unexpected, unlike a change in income If consumers adjust relatively quickly to changes in M, then C/M should be relatively invariant to such changes Instrument for change in M: Unexpected retirement

Change in C/M Less Affected by Unexpected Changes in M Dependent Variable→ ∆(C/M)∆(C/NW)∆(C/I) Independent Variable↓ Unexpected Retirement between 2001 & (0.4) (-1.0) 0.267*** (3.5) R

Conclusion Empirically, full wealth, M, and C/M match expected distribution characteristics The level of C/M has less correlation with tested circumstances than either C/NW or C/I The change in C/M is relatively invariant to recent income and employment shocks and changes in M when compared to C/NW or C/I